ASIC Warns SMSF Trustees at Risk in Volatile Markets

ASIC has provided an early warning for SMSF trustees at risk due to increased trading activity in derivative investments and contracts for difference (CFDs) in the current volatile markets.

ASIC has undertaken an analysis of security markets during the COVID-19 period, which has revealed a substantial increase in retail activity as well as greater exposure to risk. They have found that some investors are engaging in short term trading strategies unsuccessfully attempting to time price trends.

The trading frequency has increased rapidly, as has the number of different securities traded per day, and the duration for holding the securities has significantly decreased., This indicates a concerning increase in short-term and ‘day-trading’ activity.

Even market professionals find it hard to ‘time’ the market in a turbulent environment, and the risk of significant losses is a regular challenge.

Short Term Trading

For SMSF trustees to attempt the same is particularly dangerous, and likely to lead to heavy losses – losses that could not happen at a worse time for many funds.

SMSF trustees who chase quick profits by playing the market over the short term have traditionally performed poorly – in good times and bad – even in relatively stable, less volatile market conditions.

The analysis suggested few pursuing quick windfalls were successful. During the focus period, on more than two-thirds of the days on which retail investors were net buyers, their share prices declined the following day. On days where retail investors were net sellers, their share prices more likely increased the next day.

In addition to the increased trading, the number of new retail investors increased sharply to the market – up by a factor of 3.4 times – and the number of reactivated dormant accounts also increased.

The higher probability and impact of unpredictable news and events in offshore markets overnight only magnifies the danger.

ASIC Concerns

ASIC is therefore mainly concerned by the significant increase in investors’ trading in complex, often high-risk investment products. These include highly-geared exchange-traded products, but also Contracts For Difference (CFDs).

Trading activity in CFDs has increased significantly during this period of heightened volatility. Leverage inherent in CFDs magnifies investment exposure and sensitivity to market volatility, so retail clients should be particularly cautious about investing in leveraged products at this time.

In the week of 16-22 March 2020, for example, retail clients’ net losses from trading CFDs were $234 million for a sample of 12 CFD providers.

SIS Compliance

Trustees can give a charge over the assets of the fund under certain circumstances which allows them to trade in derivatives from the list of approved bodies in SISR Sch 4.

Firstly, the fund’s trust deed must permit investment in derivative investments and, secondly, the investment strategy must explicitly state that the trustees intend to invest in derivatives.

Most importantly, under r13.15A SISR, a derivative risk statement must be in place, separate to the investment strategy, which outlines:

Policies for using derivatives, including an analysis of the risks associated with using derivatives within the fund’s investment strategy

The restrictions and controls on using derivatives, taking the expertise of the staff involved into consideration

The compliance processes to ensure the controls are effective

While the term derivative covers a variety of arrangements, not all derivatives are compliant such as where the fund trades derivatives, CFDs and OTC derivatives through a margin account (refer ATOID 2007/57 and ATOID 2007/58).

Under these circumstances, the trustee has contravened s67 SIS prohibiting the fund from borrowing money and also r13.14, as it creates a charge over fund assets.

Commentary

High-risk investments are possible within an SMSF, but the risks need to be understood, and the correct documentation must be in place.

Unless an SMSF trustee is a professional investor, however, it will be difficult to make reasonable returns. In most cases, the bet is against a professional and every contract entered into has a winner and a loser.